How Green Mountain Tackled its Forecasting Problem

By Annie Gasparro

Reuters

Green Mountain has finally found a way to soothe jittery investors. At least for the time being.

The maker of K-Cup coffee says it has come up with a better way to predict demand, easing investors’ concerns as the company faces increased competition in the single-serve coffee market. Shares surged as much as 35% despite lukewarm earnings, as the new increase in transparency outlined in its latest quarterly report encouraged investors.

Green Mountain’s rapid expansion since acquiring the rest of the Keurig business in 2006 has made it difficult for the company to forecast its sales of K-cup portion packs, making every earnings projection suspect.

“After the second quarter, we made it the highest priority, and we found a better way of doing it that gives us a much better handle on consumer demand going forward,” Chief Executive Larry Blanford said in an interview.

After struggling this year with excess inventory and lower production levels hurting its profitability, Green Mountain spent the past 90 days “working hard to analyze the disconnect between our expectations and consumer demand for K-cups,” he added.

Its new forecasting method takes into account beginning-of-month inventory, planned shipments and end-of-month inventory for individual retailers. In the past, Green Mountain used forecasts from its sales organization, historic brewer shipment data and consumer surveys to anticipate sales.

“For a number of years, our historical model was very predictable,” Mr. Blanford said. “But that model started to break down as we reached a certain level of saturation…and consumers were saying they consumed more than they did.”

Green Mountain said that in the three months ended June 23, lower K-Cup demand, which led to less efficient production levels, caused its gross profit margin to fall to 34.9% from 36.8% in the prior-year period.

Green Mountain said its new analysis showed people are buying K-cups more often at grocery stores, mass retailers like Wal-Mart and club stores like Costco, than at specialty retailers and department stores. The shift impacts Green Mountain’s forecast because grocery stores tend to move inventory faster than specialty retailers.

“It’s a very difficult method, partly because some retailers view consumer sales data as proprietary so we have to use third-party research, but it’s definitely the best way to run a business like this,” Mr. Blanford said.

Green Mountain’s trouble with investors took flight in October, when Greenlight Capital Chairman David Einhorn presented a now-legendary 110-page slideshow complaining of a lack of transparency and accounting errors in Green Mountain’s financial reports. Then in May, Green Mountain’s shares lost nearly half their value in one day when it announced its fiscal second-quarter earnings had also been plagued by over-estimating how many portion packs it would sell.

Green Mountain now says the company’s inability to anticipate sales was in part because it didn’t understand the impact of weather, rising K-cup prices and shifts in where people buy K-cups. Mr. Blanford said it’s still working to improve and automate the new system, “but it takes a while to get there.”

Even if it gets its forecasting under control, some analysts argue that increased competition for K-cups will force Green Mountain to lower its prices and spend more money on promotions, further squeezing its profit margin. Green Mountain says it has taken both factors into account.

The Waterbury, Vt. company’s stock has taken a beating since it reached nearly $116 in September. Even counting Thursday’s surge, the stock is still down about 50% this year.

Green Mountain’s stock is now valued at about 11 times its projected annual earnings, which investors seem to think is a fair value, compared with last year, when it reached a multiple as high as 140 times earnings.

While they didn’t say it, Green Mountain officials had to be pleased that Thursday’s rally also served to burn the company’s legion of short sellers. Some of those investors, who bet against the company by selling borrowed shares on the assumption they could be repurchased later cheaper, will end up buying Green Mountain shares to cover their positions, pushing the price even higher.

As of July 13, short investors had held about 19% of Green Mountain’s outstanding shares, according to Factset. Greenlight Capital, for instance, said last week that its Green Mountain Coffee short position was its biggest winner in the quarter. In addition to Mr. Einhorn, other short sellers have piled on Green Mountain, claiming it has overstated its profits.

Green Mountain has repeatedly denied these allegations, saying they were based on flawed research. The company has been the subject of an investigation by the Securities and Exchange Commission since 2010, which has resulted in the company restating its financial reports from fiscal 2006 to fiscal 2010.

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Comments (2 of 2)

"Shares surged as much as 35% despite lukewarm earnings ...."
For the 9 months ended Jun 23, 2012: Net income up 116.8%, sales up 50.2%, gross profit up 46.5%, Operating income up 62.2%, etc.
This writer needs to brush up on financial statement analysis..

"Green Mountain’s stock is now valued at about 11 times its projected annual earnings, which investors seem to think is a fair value, compared with last year, when it reached a multiple as high as 140 times earnings."
Fair value like evil is in the eye of the beholder.

4:47 pm August 7, 2012

James Jennings wrote :

"Shares surged as much as 35% despite lukewarm earnings ...."
For the 9 months ended Jun 23, 2012: Net income up 116.8%, sales up 50.2%, gross profit up 46.5%, Operating income up 62.2%, etc.
This writer needs to brush up on financial statements.

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